I’m Steven DeMeo, a contributing editor for MIT Sloan Management Review. I’m here with Regina Herzlinger, the Nancy R. McPherson Professor of Business Administration at Harvard Business School. Professor Herzlinger was the first woman to be tenured and chaired at Harvard Business School. She co-founded a successful medical device firm with her husband, George, has written several bestselling books, and has served on the boards of more than ten public health firms. And she is a renowned expert on on healthcare delivery an innovation. Regi joins us today to discuss a topic of interest to managers who help lead their organization’s innovation efforts, how teaming up with unlikely collaborators can help companies reduce costs, increase efficiency, and better understand and solve customers’ problems. Regi will talk about how this is playing out in the healthcare industry, specifically in mergers between healthcare retailers and insurers, like the CVS/Aetna, and Walmart/Humana partnerships that are in the works. Regi, thank you for joining us. So, my husband George and I are both MIT graduates. When I graduated, which was obviously a long time ago, there were ten women in my class, and I’m thrilled at all of the changes at MIT. My husband, George, liked MIT so much that he stuck around to get his Ph.D. in physics, but I have to confess I got my doctorate at Harvard, but I love them both. Well, we’re thrilled to have you back here to talk and have this conversation about mergers in the healthcare industry. Starting this conversation, I want to first just give viewers some basic background and for you to help us understand, very briefly, why retailers like CVS and Walmart are interested in the first place in joining forces with large health insurers and Aetna and Humana. So, it’s spelled Amazon. Amazon scares the you-know-what out of everybody who might compete with them. And for a long time Amazon was like a shy bride, on again, off again, are they going to enter the pharmaceutical space. They finally did. They bought a company that does mail-order pharmaceuticals. So, why is CVS concerned? Well, its pharmaceutical division is much more profitable than its overall profits. And Walmart, oh, my God, it’s in competition with the Amazon, not only in pharmaceuticals, but in so many merchandise categories. So, CVS, Walmart, they thought that by joining with health insurers they could sell health insurers health insurance products in their stores. And also that they could expand their stores to provide more convenient, higher-quality, lower-cost access to people for healthcare services. Now, clearly you’re not going to get your brain surgery done at Walmart, but if you have diabetes and you have very challenging daily needs to manage your diabetes, it could be very helpful to go to Walmart, which has 4,800 stores conveniently located. You could go to CVS, which has 10,000 stores conveniently located and have somebody help you manage that. Right. So, now we understand obviously why the retailers would be interested. So, what’s the advantage for the insurer in merging with a retailer? I’m thinking of merging in particular with CVS because it’s both a pharmacy benefit manager and it’s also a healthcare service provider that offers vaccines and strep tests and other services. So, what’s on the insurer side? Why do they want to do this? Well, they’re pretty threatened themselves. Insurance profits have — which were never that high — have dipped in the past few years. And one of the reasons that they dipped is that the Affordable Care Act, which is colloquially dubbed as Obamacare, has insisted that insurers pay out a certain percentage of their revenue as medical benefits. How the insurers think about these medical benefits is indicated by what they call them. They call them the medical loss ratio, as if you’re losing money by providing healthcare benefits. So, Obamacare has required a minimum of 80%, usually 85%, of revenues be paid out for actual medical expenses. The insurers typically spend much less than that on medical benefits, especially in the individual market. That means, in English, health insurance that’s sold to individuals rather than employers. So, they need to lower their costs. One way of lowering their costs is to sell through stores rather than brokers or other intermediaries. So, they have very good reasons for wanting to merge with these retailers. There is an insurance company in Florida that’s called Florida Blue. It’s the Blue Cross Blue Shield in Florida. It’s a fantastic organization. It is the only insurer in Florida that sold Obamacare policies everywhere in Florida. So, it’s a real mission-driven organization. It started health insurance stores. It has 21 of them. They sell insurance there, but they also provide healthcare services there and have been a phenomenal success. One reason is that people who find buying health insurance confusing — it is, after all, an intricate financial product—can go to these stores, and rather than interacting on the web or the telephone, they meet face-to-face with somebody who’s pleasant and informed and nice and recognizes them as human beings. And they buy health insurance in that way. So, that’s very, very important to understand how that works, I think, and we appreciate how thorough you were in explaining that. What I think now is important also to explain is how the patients themselves, the consumers, how would they benefit from this relationship? So, if they’re going to shop for insurance in a store, for example, how is that superior to — you alluded to it already already regarding not interacting through the web or interacting by phone, but how would that compare, say, with working with a navigator in a state that supplies healthcare navigation services? Would there still be an advantage to that, or would that be sort of the same thing, it would just ensure that would be rolled out nationwide because it would be available all over the place in every state, and not just those that already are offering navigation services? Well, everybody offers navigation services, whether it’s through the ACA or through commercial insurance. And, you know, Steve, people have different tastes. Some people may want to go on the web, use the navigator or similar products that the commercial, meaning the insurers who are not on the Obamacare platforms, use. And some people may prefer face-to-face. What Florida Blue found is in its markets many people prefer face-to-face interactions, and they structured their stores so that they respected the individuality of the community. For example, in South Miami they serve Cuban coffee. People who serve those stores are of Cuban heritage and speak the specific language that Cuban-Americans might be more comfortable with. And they wear Cuban types of shirts. So, this is an example of how face-to-face interaction is more personalized, more humanized than going through a navigator. But that’s not all that CVS is going to do. CVS is transforming itself into a healthcare store, and it walked the talk. It threw out cigarette sales. That’s $2 billion worth of revenues that they threw out. So, and not just saying we’re healthcare, we’re going to provide wellness, we’re wonderful, they actually lost $2 billion in revenue. So, what are they going to do? In their 10,000 stores they have 1,100 MinuteClinics, which are retail medical centers that provide medical care. And rather than only providing vaccines, which is very important — the rate of vaccination has jumped because it’s so convenient — they’re also going to help monitor chronic diseases, starting with diabetes, which has, as you well know, so many other problems: heart disease, kidney disease, depression. Terribly difficult disease to manage. . Also, hypertension, high blood pressure, too much cholesterol, other chronic diseases with which people need help. There’s a terrific analysis that shows that people who go to get their chronic disease care at the top quartile of primary care physicians who are fragmented—in other words, they are not connected with other parts of the healthcare system—have much higher rates of hospitalization and cost about $4,500 more per person. CVS can help that. Primary care doctors are tremendously overloaded and really burned out. CVS and other retailers can help [lever] the primary care providers by delivering this kind of monitoring care. So, part of that, of course, is when patients and consumers are getting more primary care at a retailer, let’s say CVS, to manage their chronic diseases. There’s a boost, then, in the use of the primary care services, which of course makes sense, and then has downstream benefits because things are being caught earlier and diseases are being managed better. And there was even a study out recently that showed, a study of more than a million Aetna enrollees, that showed that when they had retail options they did increase the use of those primary care services. So, then the question becomes how should the companies manage the companies themselves that are delivering these services that are the insurer and the retailer? How should they manage? What are the management implications implications for dealing with that change? So, if there’s an overall benefit in cost reduction and disease care, but how do the companies manage that transition? Well, they have to do it well. They have to have good protocols. They have to make sure that their medical staff—in the case of CVS it’s nurse practitioners, who are brilliant people who receive extra training to do their job, that they’re trained in doing it, that they monitor that the protocols are fulfilled. So, there was another study that showed that in three common diseases retail medical centers like CVS provide higher quality care at a lower cost than emergency rooms and ambulatory care facilities. Now, I’m not touting CVS or Walmart or Walgreen’s. They’re actually not that great in customer service compared to a supermarket like Publix, which is a southern chain, and which is superlative in customer service. It’s continuously rated number one. So, these retailers will have to up their game in order to do all of this, but what they have to do is not rocket science, and they’ve done it before in their other medical care ventures. So, they can learn from other organizations that have learned how to do that well and recognize what their own deficiencies are? I wouldn’t say their deficiencies. I would say they’re not great compared to an organization like Publix. There’s a lot to learn. Some people might laugh and say gee whiz, Publix, a supermarket in these retail medical chains? Well, consumers right now rate health care as the third worst business sector. They’re very dissatisfied with health care. Specifically the kinds of things that make them dissatisfied is they have to wait 24 days for an appointment, and when they have an appointment it takes two hours, 20 minutes of which are spent on medical care. So, there’s room for improvement. The heads of CVS and Aetna understand that, so if this merger goes through in a joint statement they said we’re going to improve the customer experience. That’s very important. It’s not just retailer buzzwords. It’s making sure that people who need medical care get it promptly, get it in an integrated fashion, get it in a dignified way. We now talked about the retailers. We’ve talked about the insurers. We’ve talked about the customers and patients. So, now what are the implications of this vertical integration between a retailer and an insurer? What are the implications for health systems and care providers like the hospitals and the physicians? How will a merger like CVS/Aetna, for example, affect those folks? Terrific question, like all your questions, Steve. So, clearly, they’re going kind of to cut into the business of hospitals, ambulatory care facilities, urgent care facilities, emergency rooms. That’s good for society because care will be provided in more cost-effective sites than those. The hospital that have vertically integrated to have those facilities, they can do one of two things. They can change and recognize that ambulatory care in general in hollowing out hospitals, or they can fight it and say CVS can’t do brain surgery, or limit the expansion of the stores. There are some visionary healthcare systems that have seen the handwriting on the wall. For example, Geisinger, which is a very innovative healthcare system in central Pennsylvania, it’s building micro-hospitals, which are little hospitals with about eight rooms. And the idea is people come there, and if they need an overnight stay, they’re going to be placed in that hospital, but most of the care will be on an ambulatory basis. That’s in contrast to these mega 500-bed hospitals that other systems are still building and that burden the U.S. healthcare system. A study of why costs are so high in the U.S. relative to other countries showed that a major reason is it’s the prices, and hospital prices in the U.S. dwarf those of other countries. So, one of the things that’s happening is innovation, of course, on the part of the retailers and the insurers, and it sounds like you’re saying that when that happens there will have to be a kind of corollary set of innovation steps that happen on the part of hospitals and providers. Is that fair to say? That’s very well put. To put it another way, when you have competition, when you have different models of care delivery, all boats rise in sync. The retail insurers are going to innovate, and they have to do better at what they do. And the hospitals will have to innovate. So, it’s interesting, this merger between CVS and Aetna. It’s gotten a lot of press. And, actually, in the past week there was some reporting by CNBC that said that the Department of Justice is unlikely to stand in the way of this merger So, that is one big hurdle that will be cleared and, so, making the merger that much more likely. But in June, before that reporting occurred, the American Medical Association came out with a statement against the merger. So, despite all of the many benefits that you’ve pointed so far in this interview, they pointed to what they consider downsides. The associations that are downsides for providers and patients, they cited increases in drug spending and out-of-pocket patient costs, and higher insurance premiums when competition for insurance in particular markets go down. They specifically mentioned Medicare Part D because there are — collectively,
00:21:06.0 CVS and Aetna, for example according to a Bloomberg analysis, about a third of Medicare Part D enrollees when it comes to pharmacy benefits. So, what would you say to the AMA when they come out and say this about this potential merger? What is the AMA missing, if anything? The AMA has a point, but not in this case. CVS has managed Aetna’s pharmaceutical benefit management for many years. So, this merger is not going to increase their share of pharmaceutical benefit management. They’ve always managed Aetna’s So, the point in regard to this merger, that the merger of pharmaceutical benefit managers — these are health insurers who manage pharmaceutical products — the point in this case is a little puzzling because there will be no change. The general point, however, that the AMA makes, and that is when insurers consolidate premiums go up, that’s virtually indisputable. It is a very serious challenge, and it’s a challenge that the Department of Justice and the Federal Trade Commission need to take seriously. It is a particular challenge to fragmented physicians. If your physician is in a solo practice or in a little practice with, let’s say, nine other physicians, how are you really going to negotiate effectively with an insurer that’s dominant in your market? So, AMA, kudos to you for raising the flag on the dangers of health insurance consolidation, but in the CVS/Aetna case, I don’t get it. If this is a naïve question, please feel free to say so. So, let’s say this CVS/Aetna merger and the Walmart/Humana merger, they go forward. Could the retailers refuse to offer pharmacy benefit management services to insurers they aren’t partnering with? Or even start turning down contracts to fill prescriptions from other insurers’ members? Is that something that’s a risk potential here? Seriously? Pharmaceutical benefit management is a fixed-cost business. Their revenue more or less falls right down to the bottom line. So, why would you turn away extra customers? Right now CVS manages the pharmaceutical benefit management of Anthem, which is the second largest insurer in the United States. It’s conceivable, but it would be a very questionable business decision to turn away the business of other insurers, given the economics of this particular sector. Even after the merger occurred, though, and Aetna and CVS are now joined, you still don’t see that as a high risk? Well, right now CVS manages Anthem’s pharmaceutical benefit management business. Anthem is a giant. Aetna is big, but Anthem is a giant health insurer. So, it’s demonstrating the business proposition that when you have a fixed-cost business, which is managing a PBM, you’re not going to turn away additional customers. Why would you do that? So, those are not the Anthems and the Aetnas, because of the fixed cost. But because it’s a fixed-cost business, the incentive will be to continue serving those customers. Plus, remember, the scary one is in the business now. So, Amazon bought a little company. It had $100 million in revenue that’s in the in the mail-order pharmacy business. It paid ten times revenues for them, a staggering sum. So, your worst nightmare is competing with you in the PBM business. Are you really got to play hardball and turn away customers? I don’t think so. For those watching, that’s PillPack. That is PillPack. PillPack, by the way, is an MIT-started business, so kudos again to MIT for its amazing success in the innovation. So, now when a healthcare retailer and an insurer actually merge, goes forward, all of the costs and benefits of these mergers and benefits on balance, you’ve made the case, are imminent, what steps should the insurers and the merged entities do to mitigate what risks there are, what risks do exist, as there would in any innovation? When any innovation starts to get implemented, there are some risks. What should they do to rein in costs and, most important, to quiet their critics? So, whether it’s the AMA or other folks who criticize the merger? Very good question. So, you’ve got to walk the talk. Strategy is great, but God or the devil or somebody important is in the details. You’ve got to execute well. Executing well means being a very effective retailer and being a very effective medical care and health insurance provider. I’m now saying I have to give a shout out to CVS for dropping its cigarette sales. That may not sound like a big deal, but to a publicly-traded company losing $2 billion worth of revenue means they’re quite serious about this. So, execution is very important. How do you deal with the critics? So, whatever you do that threatens the status quo in whatever industry it is, they’re going to go after you, and the stakes are enormous in this case. So, one group that’s threatened by this are the primary care providers, and the AMA is a main representative of the primary care doctors. I think this merger will help those doctors, not hurt them, because it’ll take away work that CVS could be doing instead of the primary care provider and enable those primary care providers to focus on their great skill set. And, as you know, there’s a shortage of these vitally important doctors, and most doctors, they spend over 50% of their time right now on IT and billing, and much less on patient care. CVS can help them. So, now it’s up to them — CVS, Walmart, Walgreen’s, whoever enters the business — to structure relationships with primary care providers that make it clear that they’re not invading their turf, but rather enabling them to do what they studied medicine and have practiced so well for so many years to do. That they’re not in competition, they’re actually a lever to them. As, you know, these physicians are increasingly getting burned out, and monitoring chronic diseases, for example, CVS is hooked up to an IT system that most of these physicians are on as well, so they can transmit the data very readily to them. That’s a plus, not a minus. Same thing with the hospitals, that CVS can lever them. Although in the case of hospitals, American hospitals are about a third empty on the average. So, they’re not overworked the way the primary care providers are. But it is inevitable that this will happen, so you may as well work cooperatively with them. Working cooperatively means, for example, structure and referral over insurance. So, if a diabetic is in bad shape, that person is immediately referred to and hopefully transferred to an advanced medical care facility that can help them. So, to deal with the critics, which are true in every industry, none of the stakeholders like innovation. They’re afraid it’ll be disruptive. It’s true in this case as well. The innovators have to ensure that they make clear to the powerful status quo that they’re not taking away they’re levering, or that the changes they are representing in the case of hospital, the movement to ambulatory care are inevitable, so let’s make this work as well as possible. So, what would you say is the biggest danger for the innovators themselves in terms of either addressing the critics or some other pitfall that has nothing to do with that, that you, from your wealth of experience and research and everything else in your career, that you have seen when companies innovate? Maybe if it’s not even in the healthcare industry, but in general, what are the one or two big pitfalls? Is it mostly addressing the critics, or are there other things that are kind of things that always stand out that the innovators often fall down on? Well, M&As, mergers and acquisitions, typically don’t work. And they don’t work especially if the merged parties are in very different businesses. So, CVS is a retailer, but as it happens, it’s also a health insurer through its pharmaceutical benefit management business. Being a retailer is very different from being an insurer. If you think of it simply, who would you want as the CEO of a retail company? Would you want somebody out of the health insurance business to become the CEO of, let’s say, Walmart? No, you wouldn’t. But in this case the retailer already is, in fact, primarily is an insurer and a retailer. So, always a challenge in M&A is to achieve the synergies that are promised, and that challenge is frequently not met. It’s a challenge in this case, not just CVS/Aetna, but Walmart with Humana, Walgreen’s with Humana or other insurers. United, which is the largest healthcare insurer is moving aggressively into the healthcare delivery business. It’s to making M&A work and being honest. It’s important that people get health insurance. It’s important that they get high quality medical care. It’s important that our costs, which are leading a death march across the American economy, that those get controlled. So, it’s important to interact well with public policy and to demonstrate high quality, to demonstrate cost reduction, to demonstrate that consumers who rate health care so low are actually getting a better experience. So, it’s not just sending a million lobbyists down to D.C. to lobby the issue, but actually affecting the changes. You may not know this, but hospitals are very powerful. You probably do know this, Steve. So, in Massachusetts, Partners, which is the largest healthcare system in Massachusetts is also its largest employer, and the largest spending on healthcare lobbying comes out of Partners. So, it’s important that when it comes to public policy it’s not all about talking heads, but but that there’s genuine demonstration of better quality, better cost, more convenient, courteous, humanizing access to medical care. Of course, some of those benefits would take time to accrue, so there might be communication challenge perhaps on that front, where maybe some of the cost benefits might kick in a little earlier and be easier to demonstrate, but kind of the long-term benefits for patients in the healthcare system would take a little longer. And, so, there might be a challenge. Would there be a challenge in that and the disjuncture between those two things in terms of communication? That’s a great question. So, there are protocols for managing chronic diseases, and they’re very challenging because a person with diabetes doesn’t just have diabetes. They have heart disease, kidney disease. There are many understandably depressed by this challenging disease that they have. So, rather than showing quality improvements in the short term, it would be very valuable to show process improvements. Yes, we’re checking glycosylated hemoglobin, which is a measure of how well the diabetic is doing when measured regularly. Yes, we’re measuring how people with congestive heart failure, a dreadful disease that costs $130 billion a year, and it’s usually very mismanaged. We’re checking how well they’re doing. If they’re not doing well, we help them as much as we can by providing convenient support in those stores, and if they need more, we’re referring them to our partners in the healthcare continuum. So, I think that quality metrics can be responded to in the short term, but there’ll be process metrics. Yes, I’m doing what the protocols say I should do, rather than I have improved the quality of life of the diabetic or the person with congestive heart failure. Just for views, glycosylated hemoglobin is what people know as A1C. That’s what I think most people with diabetes and those who serve them refer — they use that term for it. So, just to sum up, there’s obviously a vigorous debate going on and a lot of transformation happening on the innovation front in the healthcare industry. If you had to give one kind of big picture, overarching bit of advice, or takeaway message from the interview to folks, what would that be, if there’s something at a mile-high level? But to the extent that there are businesspeople who buy health insurance or are interested in health care, the overarching message is that the healthcare system is changing. And rather than being hospital-centered, it’s becoming more and more centered in ambulatory care, meaning care that’s provided in convenient locations that typically is high-quality care and lower-cost care. And it’s something that they should support in their benefit plans or in their counseling to their employees. Thank you so much, Regi, for that important insight and for all the others you shared with us today. They were very thorough and enlightening, and we appreciate the time that you spent with us. It’s been a pleasure talking to you here at MIT Sloan Management Review.